US economy strong, but relies on 'unprecedented borrowing'

[HenryTo]

Like I said before, I think the current account deficit will narrow quite a bit this year, given the slowdown in foreign reserves held at the Fed and the subsequent slowdown in global economic/trade growth.
----------------------------------------------------------------------
US economy strong, but relies on 'unprecedented borrowing': IMF
Fri May 27, 5:34 PM ET

The US economy has "solidified" over the past year and the outlook is favorable, but is relying on "unprecedented borrowing" from foreign sources, the International Monetary Fund said.

The IMF staff's latest report card on the US economy said it remains "the main locomotive of global growth," outperforming the other Group of Seven industrialized.

The US economy should grow at a pace of around 3.5 percent in the next two years as the expansion matures, the IMF report said.

"Over the past year, the expansion has solidified as robust productivity growth and high corporate profits have contributed to a strong rebound in business investment and an acceleration in employment," the report said.

But it added that there is no sign that the large current account deficit will be reduced.

Returning to a familiar theme, the IMF staff said the low household savings rate and large federal budget deficit creates a number of vulnerabilities for the economy, including the possibility of a large slowdown of household spending especially if the housing market were to cool.

At the moment, foreign investment flows are taking the place of low US savings. But an abrupt shift in these flows could lead to higher interest rates and disorderly capital markets, the IMF staff warned.

"A record-low household saving rate and a large federal fiscal deficit are being supported by unprecedented borrowing from foreigners and domestic firms," the IMF said.

"This unusual constellation of financial flows has sustained growth by keeping long-term interest rates low and stimulating house prices. However, this creates a number of vulnerabilities, including the possibility of a marked slowdown of household spending, particularly were the housing market to cool."

A more detailed report on the US economy from the IMF will be written after the IMF executive board reviews and comments on the staff report.

The IMF staff praised the Fed's handling of monetary policy, saying that its "skillful communications strategy" has allowed a gradual pace of tightening.

The IMF said that reduced slack in the economy now implies a less benign inflation outlook. It said the Fed was right to warn financial markets in its May 3 statement that more forceful tightening might be required if price pressures continue to intensify.

The staff repeated the IMF statement that the US administration's plan to cut the deficit in half by fiscal year 2009 is welcome but not ambitious enough.

It said Washington should "explore options for revenue enhancements" and not just examine ways to simplify and improve the efficiency of the tax code in a revenue-neutral manner.